Notes for a Course in Development Economics

Notes for a Course in Development Economics

Debraj Ray Version 3.37, 2013.

CHAPTER 1

Introduction

Open a book -- any book --on the economics of developing countries, and it will begin with the usual litany of woes. Developing countries, notwithstanding the enormous strides they have made in the last few decades, display fundamental economic inadequacies in a wide range of indicators. Levels of physical capital per person are small. Nutrition levels are low. Other indicators of human capital such as education -- both at the primary and seconday levels -- are well below developed-country benchmarks. So are access to sanitation, safe water and housing. Population growth rates are high, and so are infant mortality rates. One could expand this list indefinitely.

Notice that some of these indicators -- infant mortality or life expectancy, for instance -- may be regarded as defining features of underdevelopment, so in this respect the list above may be viewed, not as a statement of correlations, but as a definition of what we mean by development (or the lack of it). But other indicators, such as low quantities of physical capital per capita, or population growth rates, are at least one step removed. These features don't define underdevelopment. For instance, it is unclear whether low fertility rates are intrinsically a feature of economic welfare or development. Surely, many families in rich countries may take great pleasure in having a large number of offspring. Likewise, large holdings of physical capital may well have an instrumental value to play in the development process, but surely the mere existence of such holdings does not constitute a defining characteristic of economic welfare.

And indeed, that is how it should be. We do not make a list of the features that go hand in hand with underdevelopment simply to define the term. We do so because -- implictly or explicitly -- we are looking for explanations. Why are underdeveloped countries underdeveloped?1 It is easy enough to point to these inadequacies in terms of physical and human capital, but the extra step to branding these as causes of underdevelopment is perilously close, and we should avoid taking that step. Low levels of capital, or low levels of education, are just as much symptoms of development as causes, and to the extent that

1Perhaps the word "underdeveloped" does not constitute politically correct usuage, so that several publications -- those by well-known international organizations chief among them -- use the somewhat more hopeful and placatory present continuous "developing". I won't be using such niceties in this article, because it should be clear -- or at least it is clear in my mind -- that economic underdevelopment pins no derogatory social label on those who live in, or come from, such societies.

4

Introduction

they intertwine with and accompany the development process (or the lack of it), we cannot rely on these observations as explanations.

That doesn't stop economists from offering such explanations, however. More than one influential study has regressed growth rates (alternatively, levels) of per-capita income on variables such as the rate of savings and population growth. There is very little doubt, in fact, that such variables are significantly associated with per-capita income. But nevertheless, we do have to think about the sense in which these studies serve as explanations for underdevelopment.

For instance, is it the case that individuals in different parts of the world have some intrinsic difference in their willingness -- or ability -- to save, or to procreate? If this were the case, we could hang our hat on the following sort of theory: such-and-such country is populated by people who habitually save very little. This is why they are underdeveloped.

Somehow, this does not seem right. We would like to have a theory which -- while not belittling or downplaying the role of social, cultural and political factors -- does not simply stop there. We would like to know, for instance, whether low incomes provoke, in turn, low savings rates so that we have a genuine chicken-and-egg problem. The same is true of demographics -- underdevelopment might be a cause of high population growth rates, just as high population growth rates themselves retard the development process.

My goal in these notes is to talk about some of these chicken-and-egg situations, in which underdevelopment is seen not as a failure of some fundamental economic parameters, or socio-cultural values, but as an interacting "equilibrium" that hangs together, perhaps precipitated by inertia or by history. [Indeed, in what follows, I will make a conceptual distinction between equilibria created by inertia and those created by history.]

Why is this view of the development process an important one? There are three reasons why I feel this view should be examined very seriously.

[1] This point of view leads to a theory, or a set of theories, in which economic "convergence" (of incomes, wealth, levels of well-being) across countries is not to be automatically had. Actually, the intelligent layperson reading these words will find this reasoning a bit abstruse: why on earth would one expect convergence in the first place? And why, indeed, should I find a theory interesting on the grounds that it does not predict convergence, when I knew that all along? This is not a bad line of reasoning, but to appreciate why it is misguided, it is important to refer to a venerable tradition in economics that has convergence as its very core prediction. The idea is based -- roughly -- on the argument that countries which are poor will have higher marginal products of capital, and consequently a higher rate of return to capital. This means that a dollar of extra savings will have a higher payoff in poor countries, allowing it grow faster. The prediction: pooere countries will tend to grow faster, so that over time rich and poor countries will come together, or "converge".

This is not the place to examine the convergence hypothesis in detail, as my intention is to cover other views of development.2 But one should notice that convergence theories in this raw form have rarely been found acceptable (though rarely does not mean never,

2See Ray [1998], Chapters 2 and 3.

Introduction

5

among some economists), and there are several subtle variants of the theory. Some of these variants still preserve the idea that lots of "other things" being equal, convergence in some conditional sense is still to be had. It's only if we start accepting the possibility that -- perhaps -- these "other things" cannot be kept equal, that the notion of conditional convergence starts losing its relevance and very different views of development, not at all based on the idea of convergence, must be sought.

[2] The second reason why I find these theories important is that they do not reply on "fundamental" differences across peoples or cultures. Thus we may worry about whether Confucianism is better than the Protestant ethic in promoting hard-headed, succesful economic agents, and we might certainly decry Hindu fatalism as deeply inimical to purposeful, economic self-advancement, but we have seen again and again that when it comes down to the economic crunch and circumstances are right, both Confucian and Hindu will make the best of available opportunities -- and so will the Catholics and a host of other relgions and cultures besides. Once again, this is not the place to examine in detail fundamentalist explanations based on cultural or religious differences, but I simply don't find them very convincing. This is not to say that culture -- like conditional convergence -- does not play a role. [In fact, I provide such examples below.] But I also take the view that culture, along with several other economic, social and political institutions, are all part of some broader interactive theory in which "first cause" is to be found -- if at all -- in historical accident.

[3] The last reason why I wish to focus on these theories is that create a very different role for government policy. Specifically, I will argue that these theories place a much greater weight on one-time, or temporary, interventions than theories that are based on fundamentals. For instance, if it is truly Hindu fatalism that keeps Indian savings rates low, then a policy of encouraging savings (say, through tax breaks) will certainly have an effect on growth rates. But there is no telling when that policy can be taken away, or indeed, if it can be taken away at all. For in the absence of the policy, the theory would tell us that savings would revert to the old Hindu level. In contrast, a theory that is based on an interactive chicken-and-egg approach would promote a policy that attempts to push the chicken-egg cycle into a new equilibrium. Once that happens, the policy can be removed. This is not to say that once-andfor-all policies are the correct ones, but only to appreciate that the interactive theories I am going to talk about have very different implications from the traditional ones.

CHAPTER 2

Uneven Growth: A Research Agenda

The textbook paradigm of economy-wide development rests on the premise of "balanced growth"; that is, on the presumption that all sectors will grow in unison over time as a country gets richer. This view has served us reasonably well in several circumstances, particularly those pertaining to macroeconomic models of long-term growth. An implicit view that growth is balanced across sectors, or something close to it, also underlies the notion of "trickle-down", a stance that has strongly influenced development policy.

Of course, we would all agree that balanced growth is an abstraction. In many developing countries, economic growth has been fundamentally uneven. First one sector, then another, then a third have grown rapidly, but not all together. A list of some instances of this phenomenon would include: software development, the outsourcing of services, quick compositional shifts between agriculture and other sectors, the rise of export processing zones, and others. The question really is not whether growth is balanced -- it isn't -- but whether the abstraction is a useful one. For many important development questions, I believe the answer is no. This is why I would like to take the reality of "uneven growth" seriously, and use it as an organizing device for a research program.

I divide my research agenda into roughly two parts: the sources and nature of uneven growth, and the reactions to uneven growth. The first part studies the ways in which uneven growth might arise, and its implications for economic inequality. The second part studies reactions: how forces are set in motion to restore balancedness or perhaps even slow down or thwart the growth process. To many, the former may appear unimportant without an appreciation for the latter, so let me state at the outset that the second part is the more important section of the paper, and the impatient reader is free to turn to it right away. But a few introductory remarks may help as well.

In thinking about the effects of uneven growth, Albert Hirschman's tunnel parable is useful (see Hirschman and Rothschild (1973)). I present a slightly altered version. You're in a multilane tunnel, all lanes in the same direction, and you're caught in a serious traffic jam. After a while, the cars in the other lane begin to move. Do you feel better or worse? At first, movement in the other lane may seem like a good sign: you hope that your turn to move will come soon, and indeed that might happen. You might contemplate an orderly move into the moving lane, looking for suitable gaps in the traffic. However, if the other lane keeps whizzing by, with no gaps to enter and with no changes on your lane, your reactions may

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Uneven Growth: A Research Agenda

well become quite negative. Unevenness without corresponding redistribution can be tolerated or even welcomed if it raises expectations everywhere, but it will be tolerated for only so long. Thus, uneven growth will set forces in motion to restore a greater degree of balance, even (in some cases) actions that may thwart the growth process itself.

We could ignore this central issue. One reaction might be that we do not care about distribution as long as the aggregates work right. Or perhaps some form of Coasian or welfarist "compensation principle" is believed to be at work. Either reaction assumes away or simply negates a crucial set of development problems, revolving around the political economy of intersectoral or inter-group allocation.

The Hirschman parable also contains a parallel implication to which even less attention has been paid. The movement of "neighboring lanes" under uneven growth not only brings us information about what is possible, but it also defines and moulds our aspirations for the future. Economists, mired as they generally are in a context-less description of human preferences, are nowhere close to a theory of socially defined aspirations and for the doubleedged way in which they might influence individual behavior -- either constructively, via a profitable chain of investment and reward, or destructively, via frustration and violent conflict.

Considerations such as these serve as entry points into some fundamental development questions. Methodologically, they also underscore the need to look beyond traditional models, by explicitly incorporating the social basis of individual preferences and well-being, or by calling for better models of nonmarket allocations, such as those achieved through lobbying and conflict.

As for the first part of this paper, on the sources of uneven growth, I have more precedent to lean upon. Some of the earliest development models emphasized the varying roles of different sectors of the economy. Rosenstein-Rodan's (1943) view of underdevelopment hinged on a failure of coordination across a variety of interlocking economic sectors. Hirschman (1958) emphasized the concept of "leading sectors" that -- by virtue of their strong linkages to many other sectors -- would pull the rest of the economy through the development path. Nurkse (1953) and Lewis (1954) noted how agriculture might serve as a near-inexhaustible supply of labor that might fuel industrial development without a drop in per-capita food output. Rao (1952) and Ranis and Fei (1961) took these ideas further by explicitly discussing a two-sector model that combined the working of a surplus-labor agricultural sector with a demand-driven industrial sector. In some ways, my proposed framework merely draws on a part of this earlier literature and marries it to modern renditions of the aggregate growth model.

Our consideration of uneven growth leads to all sorts of questions that, in some ways, bridge the gap between the micro and the macro of development. It also highlights a number of ongoing issues in development economics in a unified way: notions of the dual economy and the possibilities of trickle-down, theories of occupational choice, history-dependence, the political economy of intersectoral allocation, socially determined aspirations, violent conflict and the question of appropriate redistribution and compensation in the process of development.

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